I had the opportunity to chat with Third Avenue Value Fund (Trades, Portfolio)'s lead portfolio manager at the firm's office in Manhattan. Matthew Fine has been with the firm since he graduated from college and has worked his way up the ranks.
The value fund was founded in 1990 when famed value investor Marty Whitman took an activist role in a close-ended fund and took over. He then turned it into an open-ended fund. Over the following decades, Whitman would invest in deep-value stocks, junk bonds and other opportunities. For many years, the funds put up fantastic returns. In the last several years, however, the fund's returns have been lackluster, probably since international and value have been out of favor. Regardless, its returns have been excellent over the last 30 years.
Whitman was a veteran of World War II. He gave a naming gift to my alma mater, the Whitman School of Management at Syracuse University. He passed away three years ago.
The first stock Fine discussed was FedEx Corp. (FDX, Financial). The stock was doing poorly prior to Covid. The company was pouring money into its facilities and had bought out Dutch-based TNT. The company was also trying to beef up its weekend delivery business and was delivering less than full loads. The trade war with China didn't help things either.
Fine pointed me to a podcast on Longleaf's website with CEO Fred Smith. Smith talked about how FedEx has invested in hubs and other assets in place that its competitors and the post office do not have. In regard to e-commerce, the company can implement same-day delivery on some of its items like Nike (NKE, Financial) shoes. The stock lagged because so much money was going into property, plant and equipment. Also, FedEx purchased Holland-based TNT, which was far less profitable.
When Third Avenue bought FedEx last year, the stock traded at 10 times depressed earnings, according to the firm's newsletter. Third Avenue sold the stock for a nice profit.
Another purchase was Korn Ferry (KFY, Financial). The executive recruiting firm let a lot of employees go. In a past letter to shareholders, it was noted that Korn Ferry is very profitable but has been out of favor with the Covid shutdown. The newsletter also notes that Korn Ferry should do well when hiring resumes.
In a recent conference call, management noted that after the Great Recession, sales dropped 43% in a quarter and then 32%. During Covid, sales only dropped 8%. Management thinks earnings per share will be 95 cents to $1.05 this year. On the low end, that would put the stock at a price-earnings ratio of 60. Third Avenue bought into Korn Ferry in the summer of last year. The stock is up about 100%, so you may have missed your buying opportunity.
CK Hutchison (HKSE:00001, Financial) is a classic Whitman-type pick. Fine pointed out that the Hong Kong-based sold off its telecom tower business to Spain-based Cellnex (XMAD:CLNX, Financial) for 10 billion euros ($11.9 billion). Cellnex then leased back the towers back to CK. Fine noted the value of the telecom business when it was part of CK was valued at about a multiple of 6 times enterprise value, but was sold at a multiple of 33 times. In other words, CK was trading at a discount to multiple of net asset value in the neighborhood of 50%.
CK's stock has not reflected this. Perhaps the market is concerned with China taking over Hong Kong. This is your classic Third Avenue pick. You find a conglomerate with undervalued pieces and wait and wait until something breaks lose. The stock is down about 40% from 2018, before strikes in Hong Kong and Covid and the myriad of other issues. It appears to still be on sale.
Seven & I Holdings Co. (TSE:3382, Financial) operates in the U.S. as what you know as 7-11 convenience stores. Seven & I bought out Speedway from Marathon (MRO) and is now the largest operator of convenience stores in the U.S.
In the quarterly newsletter, management points out the cost savings synergies to be tremendous with the buyout. Seven & I borrows for as little as 6 basis points in Japan. Fine noted how the company will move many of Speedway's stores to sell more food and the profit margins are much greater. Leasebacks of properties can be a further savings and source of cash. If Seven & I traded at similar multiples as its competitors, it would trade at a much higher price. The stock is only up slightly since Third Avenue bought the stock last year.
Vancouver-based Interfor (TSX:IFP, Financial), which produces lumber, wood and milled products, has done incredibly well with the lumber shortage. There is a glut of tree farms in the U.S., but a dearth of mills. You want to be the mill in this business—not the tree farm in Georgia. The company should have a massive free cash flow and has been paying down debt and buying back shares with the surplus.
The newsletter pointed out that CIBC predicted Interfor would produce $300 million in earnings before interest, taxes, depreciation and amortization on an enterprise value (equity plus debt) of $850 million. Since spring of last year, the stock is up about 400%. This is your classic Third Avenue pick. When everyone is running around talking about housing, Third Avenue is off in Canada, buying a small-cap lumber mill.
Houston-based Eagle Materials Inc. (EXP) has two divisions. The first is aggregates like cement and the second is wallboard. Competitors have been raising prices in these industries by high teens. When Third Avenue made its purchase in the beginning of 2019, the fund noted Eagle was a large producer of gypsum board, which is a byproduct of coal ash. As coal power plants are shuttered, gypsum will become more scarce. Eagle is also a producer of frac sand. At the beginning of 2019, natural gas was down in price, which affected the frac sand business. The stock is up about 100% since early 2019.
As I was talking to Fine, I remembered Eagle has a series of BBB-rated bonds with a nice yield. The yield to maturity is 3.695%, but, unfortunately, the yield to call is only 0.299%. So if it's called away, you only receive 0.299%. That's not that great.
Old Republic International Corp. (ORI) specializes in title insurance, specialty property and casualty insurance, and has a run-off book of mortgage insurance. The dividend yield is about 4.5%. That's ridiculously high in today's low interest rate environment. The price-earnings ratio is about 10. Again, it is cheap. Part of the reason why is that the previous management team didn't like to work with investors. They didn't return investors' calls and had very little information on the investor relations website. This has changed with new management.
The company got out of the mortgage insurance, but still takes in premiums and pays out claims. In my opinion, most of these home owners are not going to default on their loans as they've been home owners for several years. As home owners refinance their loans, Old Republic will lose these policies. The company has taken in a lot of capital as these policies run off. If the company were to break up its title insurance and its insurance business, the two divisions would trade at a big premium, according to Fine. The stock is only up about a third from when the fund began buying shares early last year.
Third Avenue's deep investing often takes the fund into commodities that are in the trough of their economic cycle. The tough thing is that it's impossible to find the bottom and it can take a long time before the cycle turns back out. Copper has been in the news as of late because it's booming, but this wasn't the case when Third Avenue bought Capstone (TSX:CS) and Lundin (TSX:LUN).
Fine said that the break even point for Lundin was $1.40 a pound for copper and $1.80 to $1.90 for Capstone. At $4.14 a pound for copper, both companies are in the black. I remember when Third Avenue bought in a few years ago. You would have had to have been patient.
I like Third Avenue. Our firm bought in about 13 years ago right before the Great Recession. We're up about 50%, which on an annual basis is not that much. However, Third Avenue tends to do better when markets are not at all-time highs. I think it's a great fund for investors who aren't chasing bitcoin and Amazon (AMZN). I highly recommend looking at the fund's holdings and reading quarterly reports.
Disclosure: We own shares.
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